Small Cap Strategist is published by Crystal Equity Research an independent research resource on small capitalization stocks. Follow along as we discuss the most recent trends in the small-cap sector, investigate interesting companies and pan a few not-so-promising stocks.

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Friday, February 08, 2013

European Utility Between Rock and Hard Place

Dusseldorf-bassed
E.On SE
(EONGY:OTC/PK, EOAN: DE)
is about as integrated as any utility on the planet.Name an energy source from coal to nuclear to
hydro, biofuel to solar and E.On has a grid-connected plant in operation.Besides its core business of electricity
generation, E.On has a foothold in gas production, storage, transport and
supply. It is also trying to become one
of the ‘cleanest’ power generators by joining the Test Center
Network, a collection of
utilities and technology developers focused on carbon capture solutions.Two other network members were profiled in
the most recent two posts-Southern Co. (SO:NYSE) and Enel
(ENEL:MI).

﻿﻿Like
these sister electric utilities that operate extensively in the North America
market, E.On looking down the long barrel of carbon emission standards in
Europe.The European Union Emissions Trading System (EU-ETS) was the first cap and
trade system in the world.Carbon emitting
entities receive an allowance based on historic emissions.If actual emissions are lower than the
allowance, a tradable ‘surplus allowance’ is created.Entities emitting more than their allowance
can buy the surplus to cover their deficit.Proceeds from the sale of surplus allowances are expected to off-set the
investments required to reduced emissions.

﻿﻿

With
a string of carbon dioxide belching coal- and gas-fired power plants in its
inventory, E.On has an emissions ‘deficit’ headache. About two-thirds of its power generation comes
from fossil fuel. Even if the company
could afford to write off its investment in fossil-fuel generation, shutting
down coal- and gas-fired plants is not practical.E.On is still coming up short on being able
to deliver low-emission power to its customers, despite extensive investments
in renewable power sources.E.On must
extend the runway its fossil-fuel power plant assets.

The
plan is to install next-generation coal-fired plants capable of significantly
higher thermal efficiency with steam temperatures reaching 700 degrees
Centigrade compared to a range of 500 to 600 degrees in older plants and 350
bars of pressure compared to 240 bars in older plants.That means less fuel needs be burned to
achieve the same level of electric power output.Since the carbon steel materials used in
legacy boilers and steam pipes can only withstand up to 600 degrees Centrigrade,
development has focused on new nickel–based super-alloys. Testing has been carried out at E.On’s
Scholven plant, which is consider among the most advanced coal-fired power
plants in Europe.It produces
electricity and steam for heating area buildings.

Fancy
piping will only take E.On so far.The
other strategy is to seize CO2 emissions before they hit the atmosphere.The company has dabbled in several capture
strategies, but has focused on post-combustion capture. This approach is the
least troublesome to install in existing power plants. There has been no recent
update on E.On’s internal development progress so it is no surprise that it
joined the Test Center Network group in hopes of getting a faster CO2 fix.

To
make matters worse, E.On is facing the shutdown of its nuclear power
plants.Following the March 2011 tsunami
in Japan and the subsequent accident at the Fukushima Nuclear Power Plant, Germany
policy makers mandated the shutdown of all nuclear power plants in the
country.Two of E.On’s plants have
already been shuttered.The four remaining
E.On nuclear plants are scheduled for shut down beginning in 2015 through 2022.

This
is a company that appears to be wedged between the proverbial “rock and hard
place.”The company has managed to raise
revenue in each of the last three years, but profit margins have been steadily
shrinking on higher costs.Has anyone
mentioned the weak macroeconomic environment in Europe lately?It is still weak. On the plus side, E.On
carries a bit less debt than most utilities.Even with profits down E.On has a bit more cushion to cover the interest
burden on its debt than most power generators.

Investors
have been abandoning E.On like so many rats jumping a sinking ship.The stock is trading near its 52-week low
price.As tempting as a corrected stock
price might be and as impressive as ‘going green’ might seem from social
standpoint, E.On is a stock to avoid.There are few catalysts on the horizon to break the current dynamic of
weak profits.Recovery in the stock
price appears a long-way off.

Neither the author
of the Small
Cap Strategist web log, Crystal Equity
Research nor its affiliates have a beneficial interest in the companies
mentioned herein.

1 comment:

I have always believed that the time to buy equities is when their very much out of favor. Utilities make great long term investments because of the above average dividends that many of these companies pay. While many electric utilites companies may be slow growers their dividend payouts can sometimes be as high as 5%. Not bad for a slow growing company.

About The Small Cap Strategist

Debra Fiakas, CFA is the Managing Director of Crystal Equity Research. Ms. Fiakas has a bachelor degree in economics from the University of South Dakota and an MBA from Thunderbird School of Global Management. Ms. Fiakas is a member of the Chartered Financial Analyst Institute.